Iron ore is officially in a bear market but that's no reason to give up on the mining sector, according to Morgan Stanley analysts.
The metal posted its biggest weekly loss in 16 months last week amid concern that record demand in China might ease as mills enacted winter output cuts just as data from the top user signalled the economy might be cooling.
Spot ore with 62 per cent content in Qingdao sank 3.8 per cent to $US63.56 a dry metric ton on Friday, taking the week's retreat to 12 per cent. Prices have lost more than 20 per cent since peaking near $US80 in August, meeting the common definition of a bear market. Lower-grade 58 per cent ore, which trades at a discount, has sunk into the $US30s.
Iron ore is in retreat after a tumultuous year that's seen the commodity surge in February and again in June to August, only for gains to be rolled back.
Still, the latest downward move for the iron ore price tallies with Morgan Stanley's price expectations for the metal from the third quarter of 2017.
Iron ore, metallurgical coal and copper are the most at risk of price falls, according to the analysts, who expect bulk and base metal commodity prices to fall by about 14 per cent below spot prices on average in 2018.
Taking those expected price falls into account, they prefer diversified miners as they believe these companies will be best able to offset downward moves in iron ore and coal prices by, in turn, taking an exposure to aluminium via South32 and Rio Tinto, and to oil via BHP.
The oil price soared in London trading on Monday night. Brent crude surged to its highest in more than two years as Turkey threatened to shut down Kurdish oil shipments through its territory.
"Growing prospects for capital returns adds to the attraction and we now include an additional $US250 million buyback for South32 and $US3 billion for BHP in 2019," the analysts added.
A strong equity performance since June for the S&P/ASX 200 resources sector and a generally riskier backdrop has encouraged the analysts to take a generally more defensive stance on the sector while staying positive overall.
That's expressed though a downgrade of Fortescue Metals Group from equal weight to underweight and of Whitehaven Coal from overweight to underweight.
Both are at risk of suffering from the expected commodity price corrections during the rest of the year, the analysts believe, as they also downgraded Evolution Mining to underweight from overweight, also on valuation grounds.
Overall, the Morgan Stanley analysts view pullbacks in commodity prices as potential entry points to the sector.
"[The industry] faces commodity prices that are increasingly range-bound, and a lack of production growth following years of capital expenditure cuts; however, the strong financial position and prospect for increased returns are still somewhat under appreciated, in our view."
Credit Suisse equity strategists recently took a look at potential capital expenditure trends for ASX companies, including the miners, and concluded Australia was on the point of joining a global recovery in capital expenditure.
"The recent reporting period provided the clearest indication yet that companies have a new-found confidence and guided to more investment for the year ahead," strategists Hasan Tevfik??? and Peter Liu said.
Commodity companies were expected to be a big part of that, and the sector was set to increase capital expenditure by $4 billion by next June.
The Credit Suisse strategists said companies that could grow capital expenditure as well as dividends were the companies that tended to deliver strong and consistent outperformance, and gave BHP as an example.